At Springwater, we have clients who are over the age of 70, who have individual retirement accounts (IRAs) and who do not need additional income. However, the government requires those over 70 (technically 70 1/2) to take distributions from their IRAs regardless of whether they need or want the money. For those who have a desire to give to charity, a qualified charitable distribution from their IRA can be a wonderful way to make a donation and avoid the taxes that would otherwise be assessed on the distribution.
Before we explore how this idea works, you might be wondering why the government forces people to take distributions from IRAs? Well, remember that typically (but not always) the money in an IRA has never been taxed. The account holder contributed money to the account on a pre-tax basis. The funds inside the IRA grew over time without being subject to taxation. However, the government consider this a tax-deferred account, not a tax-free account. So, at some point, the government expects to receive taxes on the value of the account. The Internal Revenue Service (IRS) rules require that distributions begin by April 1 of the year following the calendar year in which the account owner reaches age 70 1/2.
How much must you take from your IRA after your reach age 70 1/2? This amount is called your “Required Minimum Distribution” (RMD). The amount is based on life expectancy. The IRS uses a life expectancy table. For example, if you are 75 years old, your life expectancy is 13.4 years according to the table. We then look back at the value of your IRA on December 31 of the previous year. We divide that value by your life expectancy to determine the amount of your RMD. So, if you had $100,000 in your account at the end of last year, your RMD would be $7,463 ($100,000/13.4).
But what if you don’t need this required minimum distribution? If you take it as a normal distribution, you will pay taxes on it. Let’s assume you are in the 25% federal income tax bracket and that you will pay 9% in Oregon state income taxes. You would owe $2,537 ($7,463 x 34%) in taxes. Your net distribution would be $4,926 ($7,463 – $2,537).
Let’s assume you do not need the money from the distribution, but that there are some charities you would like to help. Sure, you could just give your favorite charity the remaining $4,926. But with the qualified charitable distribution, you could give the full RMD of $7,463 to charity.
Now, there are some rules you need to follow to make this work. The maximum that may be given to charity in this manner is $100,000 per year. The charity must be a public charity and not a private foundation or a donor advised fund. The contribution to the charity must be one that would be eligible for a full charitable deduction under the IRS code. The check cannot be made payable to you, it must be payable directly to the charity. It is acceptable for you to receive the check and to then forward the check to your charity.
If making a charitable donation from your IRA sounds appealing, you should consult your tax professional or financial advisor.